Financial Markets in Meltdown After Recession Warning and Loss of Trust in European Banks

Different day, same headline: the world financial markets are again in crisis, amid warnings of another global recession. The rally in global share prices last week has given way to a frantic shares sell-off, with both the FTSE 100 and the Dow Jones plummeting yesterday. Meanwhile, the price of gold, a traditional safe haven in times of financial crisis, is soaring.

What’s happening this time? Pretty much what happened earlier this month: sell, sell, sell. The UK’s FTSE 100 share index closed last night with £62 billion wiped off its value. Reporting for Reuters, Joanna Frearson pointed out that the FTSE has now dropped below the “psychological 5,000 level”. The crisis extends around the world: Nikhil Kumar and Stephen Foley wrote in The Independent that European shares have shown “their worst daily performance since the credit crunch”; and US stock futures have also fallen. Global financial services firm Morgan Stanley downgraded its forecast for world growth and suggested that the US and Europe are “dangerously close to recession”, according to Paul Panckhurst at Bloomberg.

Why? Over on The GuardianLive Blog, Dominic Rossi of Fidelity International suggested several causes, including bad US employment data, unexpectedly high inflation in the US last month and ongoing fears about the reliability of European banks. Indeed, The Wall Street Journal reported that federal investigators plan to place the US operations of European banks under greater scrutiny: “This time the worry is that the euro-zone debt crisis could eventually hinder the ability of European banks to fund loans and meet other financial obligations in the U.S.” What’s more, there is a perception that the financial summit between France’s President Sarkozy and Germany’s Chancellor Merkel earlier this week failed to generate any useful policy; this has further eroded confidence in European banks.

Fear factor. But fear is also a significant factor, according to the Bank of England. This Is Money reported that Andrew Haldane, executive director for global stability at the Bank, pointed to “an exaggerated sense of fear” as a possible barrier to recovery in the stock markets: “Haldane suggested the atmosphere of doom among traders may be just as shortsighted as the blind optimism of the boom years.” Haldane also pointed to “psychological scarring” in the financial industry after recent market meltdowns.

“Memories of financial disaster are now fresh, as after the Great Depression, causing an over-estimation of the probability of a repeat disaster,” said Andrew Haldane of the Bank of England.

Risky business. Writing for the BBC, Robert Peston was deeply concerned by the new mood of risk aversion. Peston pointed out that investors are currently seeking a safe haven not only by buying gold, but also UK government bonds (gilts) and US government debts (treasuries). “When money is flooding into US Treasury bonds and British gilts, it means one of two things: either money tends to become harder to obtain by those in the private sector who take the risks which generate economic growth and wealth; or the climate of pervasive anxiety means that even when money is available to consumers and businesses, they don’t want to spend or invest it,” he wrote. Over at The Telegraph, Richard Fletcher was also pondering risk aversion: he suggested that UK lenders need to take more risk in order to stimulate the economy, but also argued that the global markets are too unstable for this to be viable at the moment.

“To cure its addiction to debts, the United States has to reestablish the common sense principle that one should live within its means,” according to China’s Xinhua news agency.